In general, people’s decisions in the market are made on their own information and then, to a surprising degree, on the actions of others.
Over time the public seems to be less motivated by their own views and opinions, and more by the actions of others.
Although bandwagon behavior may be rational, it can be flawed.
A person going out to dinner likely would select the restaurant based on the menu offerings, the prices and, if possible, the chef’s background.
Too, if the restaurant usually is crowded, that suggests that it may be good. In reality often people copy the choices of others, explaining in part why a certain eating place is selected.
With popular music and entertainers, perceived popularity could turn mediocrity into a platinum recording. Sadly, we have learned of many instances where the data has been manipulated.
The best-seller list of books greatly enhances further sales. When deciding which book to purchase, certainly the one on the list is more likely to be bought.
We all have experienced bandwagon behaviour. Why have so many men opted to wear shorts rather than long trousers, even if the weather is cool? The fulfilling effects of popularity affect so many acquisitions.
Investors tend to base their decisions on what others say. Contrarians frequently perform well, but are inclined to be a small minority. After all, it takes collective buying to push up stocks. Majority views often defy logic. Take gold. The physical demand for gold is soaring; the U.S. Mints is running out of coins. However, the financial-paper market for gold and conventional wisdom completely ignore those facts.
Those who have been unemployed for a long time are not as likely to be hired compared to those who have been working recently. So many employers believe automatically that there must be something wrong with the jobless individual – another example of the herd mentality.
Abhijit Banerjee of the Massachusetts Institute of Technology devised a model whereby the market participants based their actions on a combination of their own data and actions of others. Over a period time those involved in the study responded less to their own actions and more to what the group does.
Clearly, investors should be wary of the bandwagon effect on share prices and economic predictions.
Group thinking often is terribly flawed.